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The Economy: A Growth Industry?

"Expansion is the normal state of the economy." -- National Bureau of Economic Research (NBER), October 2003.

"I'm buying this stock because the company is a great growth opportunity." -- Anonymous investor, any given day.

"(T)he power of population is indefinitely greater than the power in the earth to produce subsistence for man." -- Thomas Malthus, 1798.

Have you ever heard of Arthur Okun? What does he have to do with the quotations above? Well, if you are an Average Joe investor like me, the answers are "no" and "no clue."

The quotations above look at growth -- of a company, an economy, or a population -- and all except for Malthus consider it good, even necessary.

It would seem obvious enough why. More growth connotes more prosperity.

But most growth comes at some cost. A business borrowing money at, say, 7%, to fund a project that's returning, say, 3%, is actually destroying value. So while the company is growing sales and operating income in an absolute sense, it is doing so at too high a price.

Malthus' point, therefore, might make us wonder: Is there a cost to all this economic growth that might bite us in the behind? As in the threat of pending disaster?

Well, let's do some exploring. First stop is Okun's Law and how it relates unemployment to GDP growth. Then we'll look at modern views of Malthus' ideas about the dangers of growth in the presence of limited resources. So take a deep breath, and let's go.

Okun's LawIn the 1960s, Arthur Okun discovered an empirical relationship between changes in unemployment and the growth of the gross national product. That relationship has held up well since then but is now usually expressed using gross domestic product (GDP). This relationship is called Okun's Law, of course, but what is it? (As an aside, I wonder if there will ever be a Mueller's Law: "Whatever stock you buy will immediately drop 10%.")

Basically, Okun's Law says that, in general, for every one percentage point change downward in unemployment, GDP will grow two points above 3.2%. To illustrate, a 1% drop in unemployment would equate to a 5.2% growth in GDP.

Changes in economic output, or GDP, are dependent upon two things: worker productivity (amount of production per worker) and labor services (the amount of labor available). Increasing labor services depends upon several factors, including more hours per worker, population, labor force participation, other relevant factors such as worker efficiency -- and decreasing unemployment. For instance, unemployment levels have an effect upon the hours worked per worker and labor force participation. "Since [drops in] each of these factors contributes to falling output, it is clear how small upticks in the unemployment rate could be associated with larger declines in GDP," wrote David Altig, et al. of the Federal Reserve Bank of Cleveland in discussing this very issue.

Today we have come out of a recession, but recent disappointing job numbers continue to provide evidence for the arguments of those pointing to a "jobless recovery." In 2004, GDP grew by 4.4%. According to Okun's Law, we might expect this growth to have resulted in a 0.6-point drop in unemployment, instead of the actual 0.3-point drop, from 5.7% to 5.4%. Recall, though, that more goes into economic output than just unemployment. The recent changes to GDP growth have been attributed more to worker productivity than to changes in unemployment. This does not invalidate Okun's Law, as it's a "law" derived from observation and is a rule of thumb, not a mathematical certainty. One may conclude, though, that, in general, to keep unemployment low, the economy must grow, as increasing productivity will tend to erase jobs.

Growth and MalthusWe know a local deer population cannot grow forever, but can our economy? Or can any one company, Wal-Mart aside, do that?

Biologists would say perpetual growth is impossible. Eventually, resources will be used up and the whole system will come tumbling down. Robert Malthus first raised the specter of human population growth and limited resources with his writings in 1798. This premise has appeared again, and many are saying that in a world of limited resources, economic growth is eventually going to run headlong into a lack of resources to make things. Therefore, growth -- be it population, company, or economic -- is not good and should even be discouraged. The Club of Rome popularized this idea with The Limits to Growth (1972). Others continue to do so.

Recent examples include Red Sky at Morning: America and the Crisis of the Global Environment (2004) by James Speth, co-founder of the Natural Resources Defense Council; Limits to Growth: The 30-Year Update (2004) by Donella H. Meadows et al., teacher of environmental systems, ethics, and journalism at Dartmouth University; and The End of Oil: On the Edge of a Perilous New World (2004) by Paul Roberts, a business and environmental journalist whose articles have been published in Harper's Magazine, TheNew York Times Magazine, Newsweek, and Rolling Stone.

In my opinion, the argument for limiting growth fails to adequately take into account two things, both variants on the notion that unlike biology, economics is not a field bound by limited resources.

The first is the inventiveness of humans. We are forever finding ways to rearrange existing resources -- from human capital to individual atoms -- more efficiently. We invent new products, create new markets, and find new uses for junk. One example is turning something completely useless -- coal tar, a byproduct of burning coal -- into something very valuable: colored dyes for fabric. Badische Anilin- & Soda-Fabrik AG, more commonly known as BASF (NYSE: BF) , got its start with this one.

The second is that Earth is not a closed system. Energy continues to enter from solar radiation, and available energy is not efficiently harnessed. Better harnessing is an industry in itself. Kyocera (NYSE: KYO) works with solar energy; Goldman Sachs Group (NYSE: GS) is buying a private wind-energy development company.

Further, as our planet becomes more crowded, I firmly believe we will begin colonizing space and using the resources there. While Japan is contemplating building a moon base, we are seeing the first steps of free enterprise in space -- notably the success of SpaceShip One late last year and Richard Branson's bid to promote space tourism. Where will that lead? No one knows. But it certainly opens a whole new realm for economic growth and relieves the pressure of relying solely upon Earth's resources.

However, I can hear the outcry now. "Exploration of outer space is too expensive!" To be polite, hogwash. Of the money spent in space exploration so far, even at government pricing, it has all been repaid many times over, with advances in miniaturization found everywhere, with lives and property saved from improved weather prediction, and with knowledge and hope. Initial costs may seem high, but the rewards are incalculable. Richard Branson, Japan, and China all seem to believe this already. The alternative is that Malthus will be proved right and we will outgrow our planet's ability to support us.

Final wordsIn trying to answer my question, my reading led me to conclude that economic growth is a good thing, despite the gloomy scenarios of Malthus and his followers. Growth keeps people employed. It turns raw materials of all kinds into value-added products. And it will eventually lead to getting the human species into the resource-rich realm of space.

IfJim Muellerhad a spare $200,000, he would buy a seat on the next flight of SpaceShip One. However, he does not, maybe because he hasn't invested in any of the companies listed here, luckily for believers in Mueller's Law. The Fool has adisclosure policy.

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